Who gets paid first in a Company Liquidation?

Introduction

There are two ways an insolvent company can be liquidated – either voluntarily by the directors instructing an Insolvency Practitioner to convene the relevant meetings of shareholders and creditors; or compulsorily, by a creditor petitioning at court for the winding up of the company. In both cases it may well be that there are sufficient assets realised into the liquidation for payments to be made to some or all creditors. However there is a strict hierarchy in place which dictates the order within which creditors are paid and the aim of this briefing note is to provide an overview of the order of payments.

There are four main types of creditor:

Secured Creditor (split into fixed & floating charges)

Preferential Creditor

Unsecured Creditor

Shareholders

In addition to creditors there will be the costs of the Liquidator and/or the Official Receiver, which also need to be paid out of assets in the liquidation. The order within which costs are taken and creditors paid is determined by the Insolvency Act, and is outlined below.

First – Costs of the Liquidator and/or the Official Receiver

In a Creditors Voluntary Liquidation (CVL) a Liquidator, who is an Insolvency Practitioner, is usually appointed immediately by shareholders and creditors. In a Compulsory Winding Up (CWU) the Official Receiver is initially appointed Liquidator, but an Insolvency Practitioner may subsequently be appointed Liquidator if there are assets to realise or specific aspects to investigate.

The Liquidators fees are agreed with creditors via a Fee Resolution and they are entitled to recover their fees and costs first from the assets in the liquidation. The only exception to this is where the assets are covered by a Fixed Charge, in which case the Liquidator will need to seek the approval of the Secured Creditor.

Clearly the amount of fee taken by the Liquidator will have a material impact on what is left for creditors, and in the vast majority of cases this is often very little. However Bridgewood are unique in that we voluntarily offer a fee cap in liquidations in situations where we need to ensure more funds are available for the benefit of creditors. This is especially the case where the company directors are large creditors, or where they have Personal Guarantees.

As a general rule there will be more money available for creditors in a voluntary liquidation, since compulsory liquidations incur the additional cost of the petitioning creditor, legal fees, Insolvency Service fees and Official Receiver fees.

Second – Secured creditors with a fixed charge

Creditors with a fixed charge are normally banks and asset based lenders; they will hold title over a specific business asset. Details of any fixed charge are registered by the lender at Companies House, in a document called a Debenture.

The company will lose the right to sell these items, which might include goodwill, property, plant or machinery and only the title holder or Liquidator can realise the asset for the benefit of the creditor. Factoring or Invoice Discount facilities usually also have a fixed charge over the debtor book.

Third – Preferential creditors

These are typically employees of the company who are owed arrears of wages or holiday pay. However pay in lieu of notice and redundancy payments are non-preferential and will rank alongside other unsecured creditors. If there are insufficient assets in the liquidation to pay employee claims then any shortfall is covered by the Government’s Redundancy Payments Fund, subject to certain upper limits.

Historically HMRC were also treated as preferential creditors however this was changed with the introduction of the Enterprise Act, which removed their preferential status.

Although not currently ratified, if Parliament backs the recommendations from a report by the Law Society in July 2016, consumers could move up the insolvency hierarchy and be classed as preferential creditors in the future. This will apply to consumers who have prepaid £250 or more in the 6 months prior to insolvency proceedings.

Fourth – Secured creditors with a floating charge

A secured lender can place a floating charge on any asset not subject to a fixed charge. This is often stock, raw materials, work in progress, fixtures and fittings and book debts. Through the normal course of business, these can be subject to change in quantity and value. As with the fixed charge, details of any floating charges are registered by the lender at Companies House, in a document called a Debenture.

However a percentage from the sale of assets with a floating charge is set aside to repay unsecured creditors; this is referred to as the ‘Prescribed Part’. To work out the amount from realisation of assets, it is 50% of the first £10,000 and then 20% between £10,000 and £600,000.

Fifth – Unsecured creditors

These include all remaining creditors such as suppliers, contractors, the Landlord, consumers, HMRC and directors loan accounts. Any distributions are paid equally to all creditors.

Last – Shareholders

It may seem harsh that people that invested their own money into a company get paid last, however shareholders have taken a risk with investing in the company on the basis that they may get a superior return.

Shareholders will only receive payment if all the creditors and costs detailed above have been paid. In this scenario the case would turn into a Solvent Liquidation and shareholders would receive a “capital distribution”. If a shareholder was also a director then they will likely benefit from Entrepreneur’s Tax Relief.

Summary

The order and amount distributed to creditors in a liquidation is based upon a complex hierarchy. However whatever the scenario, a good Liquidator is one who; firstly, achieves the highest possible realisation for the assets and; secondly, appropriately manages their fees and costs to ensure a fair return to all creditors.

Directors have a responsibility to ensure they seek help as soon as they realise the company is insolvent and, given the option, it is imperative to choose a Liquidator who is committed to ensuring that creditors receive a fair return.

We hope this overview has been helpful. If you would like more information, or have a client who may need our services, please don’t hesitate to contact me on 0115 871 2921 or by email aftab.zahoor@bridgewood.co.uk.

Bridgewood is one of the leading debt solutions firms in the Midlands, delivering value for money solutions with a compassionate and supportive approach